Without a doubt, Nigerians have regarded the fall of the naira with apprehension. My initial reaction as well was one of dismay; however, an economist’s duty is to regard such events from an unbiased point of view. Yes, the naira has fallen. Yes, it is now trading at a record low of ₦210/$ at the parallel markets. Is this an indubitably negative outcome? Not necessarily. Commencing with the devaluation of the naira last November, the Central Bank of Nigeria (CBN) has gone to great lengths to shore up the value of the currency. Interest rate hikes. Abandoning foreign exchange restrictions - effectively barring dealers from depositing their funds overnight and preventing after-hours trading. Yes, the CBN seems panicked.
Amid the slide in the price of oil, the value of the naira has tumbled, understandably so given the country’s oil dependence. Furthermore, given the nation’s dependence on dollar denominated foreign services such as education, health services and travel, the overwhelming negative sentiment toward the devaluation is to be expected. However this wake-up call does not bode as badly as initially perceived. Yes, commodity importers are facing higher costs as they pay more naira to purchase the same amount of dollars. However, exporters and consumers working for these companies are receiving more naira in the return. In addition, new foreign investors have an incentive to procure Nigerian assets, which are now relatively cheaper.
The fact that the export market benefits in some ways from the naira’s slide is not enough to balance the wave of negativity that has spent the nation. In response to the pressure on the naira, the CBN made the bold decision to move away from a multiple exchange rate (MER) to a single exchange rate regime (SER), effectively positioning the currency closer to its ‘truer rate’. Before the switch, Nigeria was one of the 35 countries still utilising a multiple exchange rate system. This switch was crucial for a number of reasons.
A multiple system is usually transitional in nature as it is mainly used in times of economic turmoil to curb the effects of shocks to the economy. The market is divided into different segments, each with its own foreign exchange rate. However, since certain market segments are not operating under the same conditions, the economy can become distorted — an event Nigeria is currently experiencing as the exchange rate for oil becomes increasingly unfavorable. By converging to a single rate system, the CBN has essentially pooled together those that would buy for cheap in one market and sell for high in another, thereby eliminating arbitrage. The result of this is simple: Better competition and increased efficiency.
This move should help turn the negative tide that has swept the economy. Given the overall negative attitude towards the Nigerian market — Nigeria having the worst-performing stock market so far in 2015 — the switch to an SER, in other words a managed floating exchange system, bodes well in the long term as the internal mechanism of the system will lead to the naira attaining its fair value, thus restoring its competitiveness and cushioning the currency from foreign currency inflation and shocks. The panic being felt by market players can then be brought under control, as the naira’s movements will be more predictable. The naira being the worst performer among 24 African currencies tracked by Bloomberg only makes this move more crucial as some confidence should be injected into the currency as a result. This is a vital outcome considering the threat of removal from JP Morgan’s local currency indices, which would lead to higher borrowing costs.
The record lows that the naira has reached — triggering higher prices and inflation concerns in the process — should ultimately act as a wake up call. The switch from a MER to an SER is only the first step, albeit an essential one that needs to be monitored closely. The logical after-effect should be the much-demanded diversification of the Nigerian product base. This is an ideal way to ensure that the naira eventually strengthens, as the dollar will mainly be required for the goods that Nigeria cannot produce inexpensively. Furthermore, what has history taught us? That the price of oil will eventually rise as supply will undoubtedly shrink. When that will happen is debatable. But the switch to an SER provides a nice cushion for Nigeria to wear out the wave that comes when the price of oil does – and it will – rise.